Springtime DOL Updates

By George Michael Gerstein and John “JJ” Dikmak Jr.

As we await even more fiduciary-related rules and guidance from the U.S. Department of Labor (DOL) over the coming months, we take stock of some lower-profile spring updates worth noting. We begin with the DOL’s recent cybersecurity guidance, the first of its kind, as cybersecurity becomes an increasingly important issue for plan sponsors and service providers. We conclude with some new DOL guidance related to locating missing plan participants.

Cybersecurity

On April 14, the DOL released a batch of guidance that attempts to clarify best practices for maintaining cybersecurity. The first of the guidance, aimed at plan sponsors and other fiduciaries, offers tips for hiring third-party service providers and ensuring they maintain strong cybersecurity practices. The second batch of guidance offers cybersecurity best practices for plan recordkeepers and plan fiduciaries. A final release offered tips for plan participants who access their account information online but will not be discussed here. These are the first cybersecurity guidance provided by the DOL.

The following tips offered by the DOL are designed to help fiduciaries meet their obligations under ERISA in prudently selecting and monitoring service providers:

  1. Ask about the service provider’s information security standards, practices, policies, and audit results and compare them to industry standards.
  2. Ask the service provider how it validates its practices and what levels of security standards it has met and implemented. Consider looking at contract provisions that confer rights to review audit results demonstrating compliance with the standards.
  3. Evaluate the track record of the service provider, including litigation brought against the service provider.
  4. Ask if the service provider has experienced security breaches and, if so, what happened, how the provider responded, and how it was resolved.
  5. Inquire if the service provider has insurance that would cover losses caused by cybersecurity and identity theft breaches.
  6. Include ongoing compliance with cybersecurity and information security standards as a part of the service provider’s contractual commitments. If possible, include terms that will enhance these protections, such as:

a. Require the service provider to obtain an annual audit from a third-party to evaluate the service provider’s compliance with information security policies and procedures.

b. Clearly stated provisions outlining the service provider’s obligations and restrictions on the use and sharing of information.

c. Require notification of any cybersecurity breaches.

d. Specific requirement to meet all federal, state and local laws, regulations, directives and requirements related to record retention, destruction, privacy, and security.

e. Required insurance to cover losses related to cybersecurity losses. This may include professional liability, errors and omissions liability, cyber liability, and/or privacy breach insurance.

In the second batch of guidance, the DOL offered best practices for plan recordkeepers and other service providers responsible for plan-related data. The list also includes the best practices for a plan fiduciary hiring one of these service providers. These best practices include:

  1. Have a formal, well-documented cybersecurity program. DOL highlighted 18 specific areas an effective policy would cover, including data governance and classification, access controls and identity management, business continuity and disaster recovery, configuration management, asset management, and risk assessment.
  2. Conduct prudent annual risk assessments. The scope, methodology, and frequency of assessments should be codified.
  3. Have a reliable annual third-party audit of security controls.
  4. Clearly define and assign information security roles and responsibilities. This includes clearly defining the roles of upper management, especially the Chief Information Security Officer (CISO).
  5. Have strong access control procedures which cover both authentication and authorization.
  6. Ensure that any assets or data stored in a cloud or managed by a third-party service provider are subject to appropriate security reviews and independent security assessments.
  7. Perform cybersecurity awareness training at least annually.
  8. Implement and manage a secure system development life cycle (SDLC) program.
  9. Have an effective business resiliency program addressing business continuity, disaster recovery, and incident response.
  10. Encrypt sensitive data, stored and in transit.
  11. Implement strong technical controls in accordance with best security practices.
  12. Appropriately respond to any past cybersecurity incidents. This would include notifying law enforcement, informing insurers, investigations, providing plan participants with information to assist in preventing or reducing their loss, honoring contractual terms, such as notification requirements, and fixing the problems which caused the breach.

Missing Participants

Earlier this year, the DOL provided a set of best practices for fiduciaries of defined benefit and defined contribution plans to locate missing participants and beneficiaries. Some “red flags” that a plan’s current approach may be insufficient for locating a missing or non-responsive participant include a large number of missing or non-responsive participants; missing, incomplete or inaccurate contact and other pertinent information (email, social security numbers, addresses, etc.), and the absence of adequate policies and procedures for handling returned mail marked “return to sender,” “wrong address” and the like.

The DOL’s list of best practices (copied below) are those that “have proven effective at minimizing and mitigating the problem of missing or non-responsive participants.” These practices are non-exhaustive, and some may be more appropriate for a particular plan than others. Ultimately, “[r]esponsible plan fiduciaries should consider what practices will yield the best results in a cost-effective manner for their plan’s particular participant population.”

1. Maintaining accurate census information for the plan’s participant population

  • Contacting participants, both current and retired, and beneficiaries on a periodic basis to confirm or update their contact information. Relevant contact information could include home and business addresses, telephone numbers (including cell phone numbers), social media contact information, and next of kin/emergency contact information. Well-run plans regularly reconfirm that the information in their possession is accurate.
  • Including contact information change requests in plan communications along with a reminder to advise the plan of any changes in contact information.
  • Flagging undeliverable mail/email and uncashed checks for follow-up.
  • Maintaining and monitoring an online platform for the plan that participants can use to update contact information for themselves and their spouses/beneficiaries, if any, and incorporating such updates into the plan’s census information.
  • Providing prompts for participants and beneficiaries to confirm contact information upon login to online platforms.
  • Regularly requesting updates to contact information for beneficiaries, if any.
  • Regularly auditing census information and correcting data errors.
  • In the case of a change in record keepers or a business merger or acquisition by the plan sponsor, addressing the transfer of appropriate plan information (including participant and beneficiary contact information) and relevant employment records (e.g., next of kin information and emergency contacts). [DOL] has found that in the context of an acquisition, merger, or divestiture, well-run plans make missing participant searches of plan, related plan (e.g., health plan) and employer records (e.g., payroll records) part of the collection and transfer of records.

2. Implementing effective communication strategies

  • Using plain language and offering non-English language assistance when and where appropriate.
  • Stating upfront and prominently what the communication is about – e.g., eligibility to start payment of pension benefits, a request for updated contact information, etc.
  • Encouraging contact through plan/plan sponsor websites and toll-free numbers.
  • Building steps into the employer and plan onboarding and enrollment processes for new employees, and exit processes for separating or retiring employees, to confirm or update contact information, confirm information needed to determine when benefits are due and to correctly calculate the amount of benefits owed, and advise employees of the importance of ensuring that the plan has accurate contact information at all times.
  • Communicating information about how the plan can help eligible employees consolidate accounts from prior employer plans or rollover IRAs.
  • Clearly marking envelopes and correspondence with the original plan or sponsor name for participants who separated before the plan or sponsor name changed, for example, during a corporate merger, and indicating that the communication relates to pension benefit rights.

3. Missing participant searches

  • Checking related plan and employer records for participant, beneficiary and next of kin/emergency contact information. While the plan may not possess current contact information, it is possible that the employer’s payroll records or the records maintained by another of the employer’s plans, such as a group health plan, may have more up-to-date information. If there are privacy concerns, the person engaged in the search can request that the employer or other plan fiduciary forward a letter from the plan to the missing participant or beneficiary.
  • Checking with designated plan beneficiaries (e.g., spouse, children) and the employee’s emergency contacts (in the employer’s records) for updated contact information; if there are privacy concerns, asking the designated beneficiary or emergency contact to forward a letter to the missing participant or beneficiary.
  • Using free online search engines, public record databases (such as those for licenses, mortgages and real estate taxes), obituaries, and social media to locate individuals.
  • Using a commercial locator service, a credit-reporting agency, or a proprietary internet search tool to locate individuals.
  • Attempting contact via United States Postal Service (USPS) certified mail, or private delivery service with similar tracking features if less expensive than USPS certified mail, to the last known mailing address.
  • Attempting contact via other available means such as email addresses, telephone and text numbers, and social media.
  • If participants are non-responsive over a period of time, using death searches (e.g., Social Security Death Index) as a check and, to the extent such search confirms a participant’s death, redirecting communications to beneficiaries.
  • Reaching out to the colleagues of missing participants by, for example, contacting employees who worked in the same office (e.g., a small employer with one or two locations) or by publishing a list of “missing” participants on the company’s intranet, in email notices to existing employees, or in communications with other retirees who are already receiving benefits. Similarly, for unionized employees, some have reached out to the union’s local offices and through union member communications to find missing retirees.
  • Registering missing participants on public and private pension registries with privacy and cybersecurity protections (e.g., National Registry of Unclaimed Retirement Benefits), and publicizing the registry through emails, newsletters, and other communications to existing employees, union members, and retirees.
  • Searching regularly using some or all of the above steps.

4. Documenting procedures and actions

  • Reducing the plan’s policies and procedures to writing to ensure they are clear and result in consistent practices.
  • Documenting key decisions and the steps and actions taken to implement the policies.
  • For plans that use third party record keepers to maintain plan records and handle participant communications, ensuring the record keeper is performing agreed-upon services, and working with the record keeper to identify and correct shortcomings in the plan’s recordkeeping and communication practices, including establishing procedures for obtaining relevant information held by the employer.

DOL Issues Guidance on 2020 Investment Advice Exemption

By George Michael Gerstein and John “JJ” Dikmak Jr.

Just yesterday, the U.S. Department of Labor (“DOL”) released a set of Frequently Asked Questions (“FAQs”) designed to clarify certain aspects of Prohibited Transaction Exemption 2020-02, Improving Investment Advice for Workers & Retirees (PTE 2020-02). The exemption enables investment advice fiduciaries to ERISA plans and IRAs to receive a wide range of compensation (e.g., commissions, 12b-1 fees, revenue sharing, etc.) as a result of the advice without running afoul of the applicable prohibited transaction rules. As described by the DOL, “[t]he exemption offers a compliance option to investment advisers, broker-dealers, banks, and insurance companies (financial institutions) and their employees, agents, and representatives (investment professionals) that is broader and more flexible than pre-existing prohibited transaction exemptions.” We summarize some of the key takeaways from the FAQs below:

  • PTE 2020-02 is in effect (February 16, 2021). There was some confusion over this due to a memorandum from Ronald Klain, Chief of Staff to the President, regarding a regulatory freeze. The (new) DOL, however, was pleased enough with PTE 2020-02, a Trump-era rulemaking, that it waved it through. The transition period for parties to devise mechanisms to comply with the provisions in the exemption remains in place until December 20, 2021.
  • The DOL hinted at further sub-regulatory guidance and/or returning to the fiduciary investment advice regulation. No promises were made or timetables offered.
  • The DOL reiterated that a “single, discrete instance of advice to roll over assets from an employee benefit plan to an IRA” would generally not give rise to investment advice under ERISA. But, such communication could constitute investment advice if it were part of an ongoing relationship or the beginning of an intended future ongoing relationship that an individual has with the investment advice provider.
  • The DOL reminded the industry that boilerplate, fine print disclaimers that investment advice is not being provided generally won’t cut it. This echoes sentiment the DOL expressed in 2020. However, “[w]ritten statements disclaiming a “mutual” understanding or forbidding reliance on the advice as “a primary basis for investment decisions” may be considered in determining whether a mutual understanding exists, but such statements will not be determinative.” Ultimately, whether there is a “mutual” understanding that investment advice is being provided is based on the totality of the facts and circumstances.
  • The DOL reiterated that PTE 2020-02 provides relief for rollover recommendations that result in a prohibited transaction, so long as the exemption’s conditions are satisfied.
  • Investment professionals and financial institutions can provide investment advice, despite having a financial interest in the transaction, as long as the advice meets the best interest standard. Under this standard, the advice must be based on the interests of the customer, rather than the competing financial interest of the investment professional or financial institution. Investment professionals may receive payments for their advice within this framework.
  • Prior to engaging in a transaction under the exemption, a financial institution must give the retirement investor a written description of its material conflicts of interest arising out of the services and any investment recommendation. The disclosure should allow a reasonable person to assess the scope and severity of the financial institution’s and investment professional’s conflicts of interest.  The DOL cautioned that the disclosure should be more than simply having the retirement investor “check the box” to confirm that they know of the conflicts.
  • Financial institutions and their investment professionals need to consider and document their analysis of why a rollover recommendation is in a retirement investor’s best interest. For recommendations to roll over assets from an employee benefit plan to an IRA, the DOL listed the following “relevant” non-exhaustive factors to consider: (1) the alternatives to a rollover, including leaving the money in the investor’s employer’s plan, if permitted; (2) the fees and expenses associated with both the plan and the IRA; (3) whether the employer pays for some or all of the plan’s administrative expenses; and (4) the different levels of services and investments available under the plan and the IRA. The DOL also elaborated on what other factors would be part of a prudent analysis.
  • The DOL reminded financial institutions that they “must take special care in developing and monitoring compensation systems to ensure that their investment professionals satisfy the fundamental obligation to provide advice that is in the retirement investor’s best interest.” With carefully considered compensation structures, financial institutions can avoid structures that a reasonable person would view as creating incentives for investment professionals to place their interests ahead of the interest of the retirement investor. Thus, quotas, bonuses, prizes and performance standards are likely out. On the flip side, a financial institution could provide level compensation for recommendations to invest in assets that fall within reasonably defined investment categories (e.g., mutual funds), and provide heightened supervision as between investment categories (e.g., between mutual funds and fixed annuities), to the extent that it is not possible for the institution to eliminate conflicts of interest between these categories. The DOL also reminded financial institutions that the exemption requires they address and mitigate firm-wide conflicts.
  • Unlike the 2016 rulemaking, PTE 2020-02 does not impose contract or warranty requirements on the financial institutions or investment professionals responsible for compliance. Nor does the exemption expand an investors’ ability to enforce their rights in court or create any new legal claims beyond those in Title I of ERISA and the Code.

Financial institutions seeking additional information about their obligations under PTE 2020-02 may consider our initial analysis on PTE 2020-02 and its related rulemaking.

Are You Sure You Can Use the QPAM Exemption?

For many investment managers, the ability to act as “QPAM” is essential to managing retirement account assets. Indeed, status as a QPAM likely provides a sort of credentialing boost in the eyes of prospective plan clients and, more importantly, signals the investment manager’s ability to rely upon the “QPAM Exemption,” a highly versatile exemption used to cure various prohibited transactions under ERISA and Section 4975 of the Internal Revenue Code when it exercises discretion over plan assets. To be a QPAM, however, is not tantamount to satisfying the QPAM Exemption. Moreover, the QPAM Exemption itself is subject to myriad conditions, the failure to meet only one of which can wreak havoc on a compliance strategy. Here, we provide an overview and highlight potential trap doors in a Q&A format.

What is a QPAM?

A QPAM is a “qualified professional asset manager” within the meaning of Part VI(a) of the QPAM Exemption (Prohibited Transaction Class Exemption 84-14). An investment adviser registered under the Advisers Act, for example, is generally eligible to be a QPAM, provided it has total client assets under management of more than $85 million as of the last day of its most recent fiscal year and more than $1 million in shareholders’ or partners’ equity. Thus, newly formed investment managers may need to rely on an alternative exemption for trading, such as Section 408(b)(17) of ERISA, during its first year of operations.

What is the QPAM Exemption, and why is it important?

Fiduciaries of employee benefit plans subject to Title I of ERISA and plans subject to Section 4975 of the Internal Revenue Code (e.g., IRAs) must avoid entering into prohibited transactions for which no exemption is available. A prohibited transaction includes the purchase and sale of securities or other property to a “party in interest.” For example, a swap transaction with a bank would be a prohibited transaction if the bank is a party in interest to the plan client. Virtually all financial service firms will assume they are a party in interest. This is why nearly all ISDA Schedules will include representations from the investment manager that the QPAM Exemption will be met with respect to the transactions. Simply, an investment manager may be hard-pressed to enter into many types of transactions on behalf of plan clients without representing that it can satisfy the QPAM Exemption (while the bank-counterparty in this example may seek a representation from the investment manager that it is a QPAM, the bank would only be interested in knowing that in the context of ensuring the QPAM Exemption can otherwise be met).

To be fair, the QPAM Exemption is not the only game in town. It is, however, a tried and true exemptive approach that facilitates many types of trades an investment manager may want to conduct on behalf of a plan client. Reliance on alternative exemptions may be feasible from a legal standpoint but nevertheless could slow negotiations down. Practically speaking, then, it is important for most investment managers who have discretionary responsibility over plan assets to become familiar with the nuances of the QPAM Exemption and ultimately comply with it.

For purposes of the prohibited transaction rules, is it enough to be a QPAM?

An investment manager’s status as a QPAM is important, but only insofar as the rest of the QPAM Exemption can also be satisfied. In other words, the QPAM Exemption contains several conditions; to meet the definition of a QPAM itself is but one condition.

What are the other conditions of the QPAM Exemption?

Here is an overview of the other key conditions of the QPAM Exemption:

  1. The investment manager (i.e., the QPAM) acknowledges in writing that it is a fiduciary to the plan client.
  2. The entity appointing the QPAM (or entering into the investment management agreement with the QPAM) is not the counterparty (or affiliate) with respect to the transaction. There is a useful exception to this condition for commingled investment funds where no plan (or plans established by the same employer) holds a 10 percent or more interest in the fund.
  3. The counterparty is not the QPAM or otherwise related to the QPAM (i.e., the QPAM Exemption does not cover self-dealing prohibited transaction issues).
  4. No plan, when combined with the assets of other plans established by the same employer, represents more than 20 percent of the QPAM’s total client assets under management.
  5. The terms of the transaction are negotiated by the QPAM, and the QPAM makes the decision to enter into the transaction on behalf of the plan.
  6. The terms of the transaction are at least as favorable to the plan as the terms generally available in an arm’s length transaction between unrelated parties.
  7. Neither the QPAM, any affiliate, nor certain other persons have been convicted of certain U.S. or non-U.S. crimes (e.g., larceny, forgery, theft, counterfeiting, etc.) within the past 10 years. This condition has proven challenging for some large financial services firms with affiliates around the globe that may have been convicted of non-U.S. crimes.

Each and every one of these conditions have to be met.

How should an investment manager proceed?

As evident from the conditions outlined above, the QPAM Exemption cannot be put on autopilot. Investment managers should be cognizant that satisfaction of the QPAM Exemption needs to be battle-tested prior to making a contractual representation to a client or a counterparty that the exemption can be complied with by the investment manager. Investment managers should also be sensitive to the fact that some clients of theirs may conflate an investment manager’s status as a QPAM with the investment manager’s ability to satisfy the QPAM Exemption. Should this occur, both parties may have a false sense of security that the QPAM Exemption can be met for the investment mandate. The existence of non-exempt prohibited transactions by an investment manager can result in severe monetary penalties and reputational harm. If the QPAM Exemption is unavailable for some reason, one or more alternative exemptions may be available, though they should be evaluated prior to entering into the investment management agreement and any trading.